Political event contracts are typically bilateral financial agreements pursuant to which one party agrees to pay a second party a fixed sum of money in the event that a triggering political event specified in the contract occurs. For example, the first party may agree to pay the second party one thousand dollars ($1000) in the event that a specified election is won by a specified candidate. If the specified candidate prevails in the election, the contract is said to settle at one thousand dollars ($1000) and the first party pays that amount to the second party. If, by contrast, the candidate loses the election, the contract is said to settle at zero dollars ($0) and no payment is made by the first party to the second party.
Once a political event contract is defined, it may be listed on an exchange and traded by persons or entities wishing to hedge against risks that they encounter in connection with their primary activities which correlate to the underlying event used to define the contract. For example, a company doing significant business in a specified foreign country may wish to hedge against the risk that its business will decrease if there is a military coup in that foreign country. If a political event contract is available that pays one thousand dollars ($1000) in the event of such a military coup, the company can hedge as much or as little of the risk it perceives from the coup by purchasing as many contracts in the market as it deems sufficient or appropriate.
A market for political event contracts may also include speculators. Speculators are market participants who try to profit from buying and selling contracts by anticipating future price movements. Speculators benefit such a market by assuming price risk and adding depth and liquidity to the market.
Political event contracts are today listed and traded on a number of internet marketplaces such as on the internet marketplace operated at www.intrade.com. The intrade marketplace describes itself as an exchange at which traders may express a view on a wide variety of world events by buying and selling event contracts at published prices. Contracts on the intrade exchange are divided into six event categories: politics, entertainment, financial indicators, weather, current events, and legal affairs. Further information concerning the intrade exchange is available at the company's website address above.
In the United States, the operation of marketplaces or exchanges such as that provided by intrade raises significant legal and regulatory concerns. In May 2008, the Commodity Futures Trading Commission (CFTC) solicited public comments on the appropriate regulatory treatment for event contracts. See 73 Fed. Reg. 25669-74 (May 7, 2008). One significant concern voiced by the CFTC was how to address the potential gaming aspects of some contracts which may not satisfy any real economic purpose, but instead merely provide a mechanism for wagering on events of general interest. Listing of such contracts on financial exchanges could convert such exchanges to surrogate gambling venues counter to public policy.
In addition to these regulatory concerns, defining and trading political event contracts on an established financial exchange in the United States present certain practical problems. For example, because the number of potential political events from around the world that can be used as the basis for defining a political event contract is immense, it is difficult to determine which particular events should be selected to maximize the economic value of the contract and its use as a hedging vehicle by market participants. Contracts that do not provide sufficient economic value as a hedging mechanism are not likely to attract significant liquidity, making such contracts less viable and ultimately less profitable for the listing exchange.
There is therefore a need in the art for a system and method for defining, structuring, and trading political event contracts that are of significant economic value so as to maximize trading in the contracts and the likelihood that they will receive regulatory approval for trading on regulated exchanges, rather than being deemed to represent simple gambling.